English auction

What Is an English Auction?

An English auction is an ascending-price auction format in which participants openly bid against one another, with the price increasing until only one buyer remains. This format is one of the most common and recognizable types of auctions, widely used across various financial markets for selling everything from art and real estate to government securities. It falls under the broader category of Market Mechanisms, which are structures designed to facilitate the exchange of goods, services, or assets. The transparent nature of the English auction allows bidders to observe competing offers, influencing their subsequent bids.

History and Origin

The history of auctions dates back to ancient times, with records indicating their use as early as 500 B.C. in Babylon for selling women for marriage, and by Roman soldiers to liquidate war spoils.³⁵, ³⁶, ³⁷ However, the English auction, as we know it today with its ascending price format, began to gain prominence much later. The term "auction" itself is derived from the Latin word "auctus," meaning "I increase," suggesting an early form of ascending-price sales.³⁴

In England, the format became more formalized in the 17th century. The first recorded auction of a painting in England took place in 1674 at Summerset House.³³ By the late 1600s, book auctions were flourishing in London, often held in coffee houses and inns.³² Major auction houses like Sotheby's, founded in 1744, and Christie's, established in 1766, adopted and popularized the English auction format, cementing its role in the sale of fine art and collectibles globally. The simplicity and transparency of the English auction contributed to its widespread adoption and evolution into a standard format for transactions worldwide.³¹

Key Takeaways

• The English auction is an ascending-price auction where bids are publicly announced and increase over time.
• The item goes to the highest bidder at the final price they offered.
• It is favored for its transparency and effectiveness in price discovery, as it allows the market value of an item to be determined.
• A reserve price is often set by the seller to ensure the item is not sold below a certain value.
• This auction type is susceptible to certain strategic behaviors, such as collusion among bidders.

Formula and Calculation

The English auction does not involve a specific mathematical formula for calculation in the same way a financial ratio might. Instead, its "calculation" is a dynamic process driven by competitive bidding. The final price is determined by the last bid placed by the winning party, which must exceed the previous highest bid by a predefined increment.

Let (B_n) be the (n^{th}) bid placed in the auction, and (I) be the minimum bidding increment.
The condition for a valid bid is:

The winning bid (B_{final}) is the highest bid accepted before no other participants are willing to place a higher bid. The auctioneer mediates this process.

Interpreting the English Auction

The English auction is interpreted primarily as a mechanism for achieving efficient price discovery. In this format, the competitive nature of the open bidding process naturally drives the price upward towards the true market value of the item. Buyers continually adjust their valuations in real-time, reacting to the bids of others. The final price reached in an English auction is often considered a strong indicator of an asset's perceived worth among the participating bidders, as it reflects the highest amount one individual is willing to pay. This transparency fosters trust among participants and ensures a fair process.²⁹, ³⁰

Hypothetical Example

Imagine a rare collectible coin is being sold in an English auction. The seller has set a reserve price of $1,000, meaning the coin will not be sold unless bids reach or exceed this amount. The auction begins with an opening bid of $800.

1. Bidder A opens the bidding at $800.
2. Bidder B immediately raises the bid to $850.
3. Bidder C jumps in at $925.
4. Bidder A re-enters at $1,000, meeting the reserve price. The coin is now "on the market."
5. Bidder D, who was initially observing, bids $1,100, seeing strong interest.
6. Bidder B, determined, bids $1,150.
7. The bids continue to ascend, with smaller increments as the price gets higher: $1,175 from Bidder C, $1,190 from Bidder A.
8. Finally, Bidder D places a bid of $1,200. After repeated calls from the auctioneer and no further bids, the hammer falls, and Bidder D wins the coin for $1,200. This process demonstrates how the English auction continuously pushes the price upward until the highest valuation among bidders is met.

Practical Applications

English auctions are prevalent in numerous sectors, serving as a core component of various market mechanisms:

• Art and Collectibles: Major auction houses like Sotheby's and Christie's extensively use the English auction format for fine art, jewelry, and rare collectibles, both in live salerooms and online. This allows competitive bidding among a global pool of buyers.²⁷, ²⁸
• Real Estate: Property auctions often employ the English format, especially for unique or high-demand properties. This can lead to rapid sales and efficient price discovery.²⁶
• Government Securities: The U.S. Department of the Treasury uses a form of auction to sell government debt securities, including Treasury bills, notes, and bonds, to finance government operations. These Treasury auctions are crucial for managing the national debt and are influenced by the principles of competitive bidding.²², ²³, ²⁴, ²⁵
• Online Marketplaces: Platforms like eBay use an ascending-price system, where users place successively higher bids until the auction ends, and the highest buyer wins.¹⁸, ¹⁹, ²⁰, ²¹ While eBay employs a proxy bidding system (where the platform bids on your behalf up to a set maximum), the underlying mechanism is an ascending English auction.¹⁷
• Stock Exchanges: Even large exchanges like the New York Stock Exchange (NYSE) utilize auction mechanisms to determine opening and closing prices for securities, combining technology with human judgment to manage liquidity and price stability.¹⁴, ¹⁵, ¹⁶

Limitations and Criticisms

Despite its widespread use and advantages in price discovery, the English auction has certain limitations and criticisms.

One notable concern is the potential for collusion among bidders. In an English auction, since bids are public, a group of bidders (a "bidding ring" or "cartel") can agree to not compete against each other, allowing a designated member to win the item at a lower price. After the public auction, the colluding bidders might then hold a private auction among themselves to determine the true winner and distribute the savings.¹¹, ¹², ¹³ Such practices can harm the seller by reducing the final sale price and are generally illegal. The Federal Trade Commission (FTC) provides guidance on recognizing and reporting practices like bid rigging, which aim to eliminate competition.

Another common phenomenon is the "winner's curse." This occurs when the winning buyer of an item in an auction overestimates the item's true value and, as a result, pays more than its intrinsic worth. This is particularly relevant in common-value auctions where the item's true value is the same for all bidders but unknown to them, and bidders rely on their own estimates and imperfect information. The winner is the bidder with the most optimistic, and potentially incorrect, estimate.⁹, ¹⁰ Rational bidders, aware of the winner's curse, may adjust their bidding strategies downward to account for this risk, a concept known as bid shading.⁸

Additionally, the time-consuming and potentially stressful nature of the open bidding process can be a drawback for both buyers and sellers, particularly for high-value items requiring prolonged engagement.⁶, ⁷ The competitive environment, while beneficial for sellers in driving up prices, can also lead to bidders dropping out if they perceive the process as overly aggressive.⁴, ⁵

English Auction vs. Dutch Auction

The English auction and the Dutch auction represent two primary, contrasting auction formats. In an English auction, the price starts low and ascends as bidders openly compete, with the item going to the highest bidder. This method is characterized by its transparency, allowing participants to observe all bids and react in real-time. It generally fosters higher prices for sellers and can maximize market efficiency through competitive price discovery.³

Conversely, a Dutch auction operates in reverse: the price starts at a high level and descends until a buyer accepts it. The first bidder to accept the current price wins the item at that price. This format is typically much faster than an English auction, making it suitable for selling perishable goods or large quantities of identical items, such as flowers or commodities. While efficient in terms of speed, Dutch auctions offer less opportunity for competitive price discovery and can lead to lower final prices compared to English auctions, as bidders may wait for the price to drop further, risking another bidder accepting it first.¹, ²

FAQs

What types of items are best suited for an English auction?

English auctions are ideal for unique or scarce items where the true market value is uncertain, such as art, antiques, collectibles, and real estate. The competitive bidding process helps establish the highest price a market will bear.

Can I participate in an English auction online?

Yes, many English auctions, especially for art, collectibles, and even some real estate, are conducted online through specialized platforms or the websites of traditional auction houses. These often feature real-time bidding interfaces.

What is a "reserve price" in an English auction?

A reserve price is the minimum price a seller is willing to accept for an item. If the bidding does not reach this confidential price, the item will not be sold. This protects the seller from having to part with their item for less than they value it.

How does "risk aversion" play a role in English auctions?

Risk aversion can influence a bidder's strategy in an English auction. Highly risk-averse bidders might be more conservative, dropping out earlier or not bidding as aggressively to avoid the possibility of overpaying or experiencing the winner's curse.